Credit Score Improvement Through Personal Loan Management

The importance of a good credit score cannot be overstated as it gives you access to more affordable interest rates, better lending terms, and greater financial confidence. Contrary to what one might think, taking out a Personal Loan and repaying it can actually improve your credit score. It also improves by demonstrating repayment discipline, keeping a healthy credit mix, and setting up a solid repayment history. 

If you want to learn more about how you can manage a Personal Loan better so as to improve your credit rating, then you are in the right place. In this blog post, we shall explore how you can leverage personal loans to improve your financial profile and gain access to better loan terms in the future.

What Does a Credit Score Reflect? How is it Connected to Personal Loans?

A credit score measures how reliable you are in the eyes of a creditor to borrow money and repay it. Your credit report will show your current and previous financial records, how promptly you have paid back any loans in the past, and any debts that you may still have to your name. The higher the credit score, the greater will be the probability that your loan will get approved.

As personal loans are unsecured loans, lenders evaluate your creditworthiness more closely before granting them. Another crucial aspect is your repayment history, as even a single missed EMI could significantly impact your CIBIL Score. 

A credit score provides both the information, that is, your creditworthiness and repayment history, which is perfect for offering a Personal Loan.

As per a TransUnion CIBIL study, holding a credit score above 750 improves your chances of approval for expensive credit products by approximately 79%, which goes a long way to show the importance of a high credit score in the lending sector. 

Smart Strategies for Using a Personal Loan for Excellent Credit

Below are some smart ways to use a Personal Loan for the betterment of your credit score.

1.    Opt for the Right Loan Amount:
Always borrow only the amount of money that you actually need and can repay without any financial stress or difficulties. The reason is that the more debt you have, the more will be the debt-to-income ratio.

Lenders mostly check your debt-to-income ratio while analysing your financial capacity to offer you a loan. Also, as per Experian, the ideal debt-to-income ratio is 36% or lower, and if it’s higher than this, it could lower your chances of getting approved for a loan.

2.    Choose a Suitable Tenure:
Select a suitable term for repayment that strikes a balance between reasonable EMIs and overall interest costs. While a longer term may help make repayments more affordable by lowering the risk of missing EMIs, it elongates the time during which you pay interest. 

As per Reserve Bank of India's customer awareness guidelines, spreading out the payment of loans over many years might lead to an increase in your total interest paid, even if the EMI appears to be low. 

Let's say you are taking a ₹5 lakh personal loan at 11% interest for a period of three years, then it costs roughly ₹90,000. But extending it to 5 years increases interest charges to nearly ₹1.52 lakh, which is nearly double. This shows how tenure selection is influenced by both affordability and repayment efficiency.

3.    Give Priority to Timely EMI Payments:
Another important factor that influences your credit score is the timely payment of your EMIs. The reason is that your payment history and regularity of repayment have a lasting influence on your overall credit score. If you miss even one EMI, it can lower your credit score. 
This highlights the importance of making timely EMI payments and bill payments to maintain an excellent credit score.

4.    Avoid Multiple Applications:
Every time you apply for a loan, it leads to a hard inquiry. This can lower your score by 5–10 points. Therefore, only apply for a Personal Loan when needed, as it helps to improve your credit profile.

5.    Maintain a Balanced Credit Mix:
Holding both a revolving line of credit (credit cards) and instalment credit (personal loans) will help your credit score increase. If all your borrowing belongs to just one type, say only credit cards, it can limit your credit score growth. 

Having a balanced combination of credit indicates to lenders that you can handle different types of debt. Also, people having a balanced mix of credit are less likely to miss repayments compared to those using only one type of credit.

6.    Monitor Your Credit Report:
Credit rating agencies sometimes make mistakes, such as incorrect personal information, repeated entries, or fraudulent late payments, which can unfairly decrease your credit score. 

CIBIL strongly advises consumers to check their credit reports on a regular basis to spot and challenge mistakes through the online platforms. You can fix errors before they influence your credit score and future eligibility for financing by monitoring your report on a regular basis and filing objections as soon as possible.

Common Mistakes to Avoid in Personal Loans to Maintain Excellent Credit Score

Do you think that a decent credit score is enough? Here are some common mistakes to avoid while opting for personal loans:

1.    Taking Multiple Loans Together:
Applying for several loans within a short period may lead to multiple hard inquiries on your credit report. This can lower your credit score. It also raises your debt level, making repayment more difficult.

2.    Closing Old Loan Accounts Too Soon:
Repaying your loan in advance helps to reduce debt, but closing accounts too soon will harm your credit history. A lengthier credit record with regular payments improves your score.

3.    Ignoring Debt Consolidation Opportunities:
If you fail to consolidate several debts into one, you may have to pay high interest costs and may struggle with multiple payment due dates. Therefore, combine multiple debts into one to make repayment easier.

4.    Failing to Budget for Repayment:
Relying heavily on future revenue without a clear payback plan can cause cash flow problems. To avoid defaults, make sure your loan EMI matches a realistic monthly budget.

To Conclude

Managing a Personal Loan for good credit rating is easy if you pay debts on time, borrow only the amount needed, check your credit report, and maintain a balanced mix of credit. With a good credit score, you have a chance to get a Personal Loan at better interest rates, improving your financial condition during difficult situations.

Are you looking for a Personal Loan that fulfils your needs and also helps you improve your credit score? Follow the tips mentioned above and explore Personal Loan options with Poonawalla Fincorp to give your creditworthiness a boost. 

Frequently Asked Questions

1.    Will restructuring a Personal Loan reflect badly on my credit report?
Yes, if the restructuring is reported as "settled" or "written off" rather than "closed," it can lower your score and appear on your report for a long time.

2.    What can be the impact of having a co-signer for my Personal Loan on my credit score?
The impact can be either positive or negative depending on how you repay the loan. If repayments are on time, both parties will get the benefit of improved credit scores. But if the payments are delayed, both will have to face a reduction in their scores.

3.    What may happen if I convert my Personal Loan into a secured loan?
Switching to a secured loan may cut your interest rate and relieve repayment stress, but it will not directly speed up credit score improvement. The improvement remains dependent on continuous on-time payments and decreased debt levels.

4.    Will paying down my Personal Loan too rapidly hurt my credit score?
While early repayment demonstrates financial prudence, it may somewhat diminish your credit mix or minimise your credit history, both of which might impact your score. However, the impact is usually minimal when compared to the benefits of debt reduction.

5.    Is it possible to pause my Personal Loan EMIs without taking a moratorium?
Some lenders provide flexible repayment options, such as an EMI holiday or a step-up repayment plan, which allow you to temporarily reduce or suspend EMIs without requiring a formal moratorium. These choices often come with eligibility requirements and could influence the total interest payable.